Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Markets are calm on the surface, but many questions loom on the longer term fallout from the turmoil in the banking sector.- The more immediate question is whether the FOMC hikes tonight and to how willing the Fed is to guide for the rate cuts this year that the market has priced in since the recent turmoil began. All eyes on the “dot plot”! Given the market calm, markets are leaning for the Fed to go ahead with another 25 bps hike today.
S&P 500 futures rallied 1.3% yesterday as concerns over banks eased with the banks leading the increases with Canadian banks being the weakest in the session suggesting investors worried about their real estate exposure amid higher interest rates. Today’s key event is of course the FOMC rate decision with the market leading in favour of a 25 basis point rate hike which comes with a risk because the market is pricing the Fed to cut rates three times by year-end. This gap needs to be closed by the Fed, so their forward guidance and comments on US banks this time will be very important for short-term risks in US equities.
STOXX 50 futures rallied 1.6% yesterday led by banks as the UBS takeover of Credit Suisse has increased confidence in the banking system for now. It worth noting that Norwegian and Swedish banks were the worst relative performers among European banks yesterday and especially the Swedish real estate market and its risks are still in focus. Yesterday’s rally was derailed despite a weaker than expected March ZEW survey showing the Expectations Index falling to 13 from 28.1 in February suggesting investors are getting more pessimistic about the near-term outlook. With calmness setting in the question is whether investors will again begin to look at opportunities in European banks as valuations are historically low, but investors should note that risks could quickly come back into banks. STOXX 50 futures are trading at the 4,134 level this morning with the 4,175 level as the next resistance level to watch on the upside.
Hang Seng Index advanced 1.8%, driven by properties and financials. HSBC (00005:xhkg) gained 3.2% and Standard Chartered (02888:xhkg) climbed 4.4% following the relief rallies overnight in Europe and the US Treasury Secretary Yellen said the action of covering uninsured deposits “could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.” Geely (00175:xhkg) surged as much as 7.6% before paring some gains to be around 3% higher as of writing. The automaker reported FY2022 income rising 9% to RMB 5.26bn, far above analyst estimates of RMB 4.85 billion. Nio (09866:xhkg) jumped more than 6% after the EV maker expressed confidence in doubling sales this year. In A-shares, CSI300 edged up 0.3%, with computing, online gaming, software, and AI Generated Content stocks outperforming.
The US dollar is leaning lower even as market expectations for the FOMC meeting to produce another rate hike at today’s meeting have crept back higher (now more heavily favoured – more FOMC preview thoughts below) as the market still figures that the Fed is now largely done for the cycle and will be cutting rates by Q4. Still, we have had a very rapidly shifting landscape there: since Wednesday of two weeks ago, for example, the December FOMC rate “expectations” (likely mostly a function of market panicking into short-dated US treasuries on the wild volatility) have gone from the high of 5.55% to a low of 3.75% and are at 4.29% this morning. A Fed failure to hike could be very damaging for the USD on a knee-jerk reaction basis, but could incite market unease on the situation in the financial system. Elsewhere, sterling will absorb this morning’s CPI data (more below) with the Bank of England decision up tomorrow and expectations finely balanced for either no hike or a 25-basis point move before the CPI data release this morning, at least. Sterling weakened sharply yesterday after EURGBP was poking at the range lows.
Crude oil prices rose for a second day on Tuesday on signs that long-liquidation had run its course and as regulators provided more assurances on support for the US banking sector. The weakness seen overnight is mostly due to market jitters ahead of tonight's Fed rate decision with the market pricing in an 80% change of a 25-basis point hike. Russia faced with export challenges extended its 500kb/d crude output cut through June. Ahead of today’s stock report from the EIA, the API reported a 3.3m bbl increase in US crude stocks while gasoline and distillates fell. The CFTC’s weekly reporting of hedge fund positions finally caught up following the January cyber-attack, and in the week to March 14 they cut their WTI net long by 30% to 124k, a three-year low. Brent favoured due its backwardation saw its net long cut by 22% to 233k lots, an eight-week low. As the selling accelerated after March 14, we can expect most of the long liquidation and fresh short selling are now done, thereby removing a key source of selling.
The risk-on tone in the markets and higher Treasury yields took off some more shine from the yellow metal, with the Fed announcement becoming a key focus to shed some light on the financial risks and what that could mean for monetary policy in the year ahead. Gold slumped to $1940 bringing the 38.2% retracement at $1933 in focus. In the week to March 14 when gold reached $1911 speculators bought 61k lots, a 254% increase on the previous week, and buying is likely to have continued up until Monday, raising the risk of short-term long liquidation. Overall, however, gold remains in an uptrend short- and medium-term.
Meanwhile, copper rose for the fourth session to trade around $4 as concerns of a full-blown banking crisis eased and a supportive stance from the regulators continued to suggest that economic concerns could remain limited. Signs of stronger demand in China also boosted sentiment. Inventories at Shanghai Exchange warehouses fell 15% last week, while stockpiles immediately available for delivery at LME warehouses also fell this week.
Hawkish comments from ECB Holzmann on more rate hikes saw European government bond yield surge and took yields on U.S. Treasuries higher alongside. Rallies in European and U.S. bank stocks added to the selling in the front end and bear flattened the Treasury curve. The 2-year yield surged 19bps to 4.17% and the 10-year yield climbed 12bps to 3.61%, bringing the 2-10-year curve 6.5bps flatter to -56bps. The money market curve is pricing an 80% chance of a 25bp hike at today’s FOMC. The SOFR Jun-Dec spread steepened by 6bps to -48bps, trimming the amount of rate cut priced in for the 2nd half. The 20-year Treasury auction went well and around USD 6 billion investment-grade corporate bonds was issued on Tuesday.
Russia President Putin and China President Xi had a thorough exchange of discussions, where economic relations, energy cooperation, and Ukraine were discussed. Putin praised Xi Jinping's proposal for ending the war in Ukraine, saying it could be the basis of a deal when Kyiv and the West if they accept it. Russia’s statement on the use of nuclear forces softened, and Xi touted close China-Russia ties, and invited Putin to make a return visit this year.
The UK February CPI data out this morning showed inflation rising far more quickly than expected, with the headline out at +1.1% MoM and +10.4% YoY vs. +0.6%/+9.9% expected and 10.1% YoY in January. The news was no better for core inflation, which rose +6.2% YoY vs. 5.7% expected and 5.8% previously. Particularly the latter looks like an ugly re-acceleration that will challenge the Bank of England’s aggressive forecasts of disinflation for the coming two years. The February Bank of England meeting forecast that CPI would drop to below 4% by the end of this year and below 2% next year.
Nike continued its streak of reporting stronger sales than expected, with revenue rising 14% in the FY23 Q3 (ending 28 Feb) to $12.4bn, outpacing estimates of $11.5bn. However, higher freight and material costs, coupled with marked-down inventory, weighed on margins which fell to 43.3% in the quarter, slightly under the 43.7% estimate. Its most profitable region, China, reported revenue in line with estimates down 7.7% y/y to $2bn suggesting the Chinese business is not delivering any upside surprises yet despite of the reopening. Despite Nike seeing sales momentum ahead that will result in leaner inventory, the company flagged consumer confidence could face pressure. That remark also weighed on sentiment and Nike’s shares fell about 2% after hours, almost erasing the gain of 3.6% in normal trading. Still, Nike shares are up 27% in six months. We also believe Nike’s somewhat tepid outlook reflects what we could see from other consumer businesses in 2023.
The German ZEW headline showed that the economic sentiment index significantly worsened this month, arriving at 13.0 from 28.1 in January. This is much lower than the market consensus of 16.4. The current situation index was also worse than expected at minus 46.5 versus expected minus 45.8. This is mostly explained by the negative financial markets outlook and concerns about the financial sector. Both the banking sector and the insurance industry are a source of worries for investors according to the report.
With the CFTC’s reporting of weekly hedge fund positions finally up to date following the late January cyber-attack we can finally gauge their response to the price weakness seen during this time, especially the four-week period to March 14 when the BCOM grains index slumped 7%. Overall, the combined net positions in US grain and oilseed futures and options through March 14 slumped to 98k lots, lowest since August 2020, and down 82% during the past four weeks alone. Led by a record 289k lots of corn selling flipping the net to a 54k lots short for the first time since August 2020. During the four-week period corn dropped 8% and is now a strong recovery candidate should the technical and/or fundamental outlook turn more favorable.
The focus for the upcoming Fed will clearly have to address the current financial stability concerns while pretending to stay on message on inflation considerations. The US Feb. CPI data remained hot, with services inflation still sticky, and Powell's preferred "supercore" metric (which excludes shelter and rent) rose 0.5% month-on-month from 0.36%, the highest since September, so there is plenty of cause for the Fed to continue its hiking regime from the “incoming data” side of the equation.
But the Fed’s messaging on inflation will be pushed to the side as investors watch for two things: first, simply whether the Fed hikes 25 basis points or stands pat, but second and more importantly, how it positions its level of concern around recent events and the risk of a funding crisis in the banking system and therefore how it guides for the path of rates and QT from here.
On that note, the dot plot will be in the spotlight today, as the market has (with massive volatility in recent days) brought the end of the Fed hiking cycle and eventual easing forward relative to where we were two weeks ago before the recent turmoil. This morning, expectations for today’s are for +21 bps (80%+ odds for a 25-bp hike) and for a policy rate of 4.29% through December of this year versus the prior Fed dot plot median of 5.12%.
Today’s key earnings report to watch is Tencent, China’s largest technology company, which is expected to report revenue of CNY 144.5bn up 0.2% y/y as growth has come to a standstill as increased technology regulation has made operating conditions more difficult. Tencent’s difficulties with growth is due to less uptake in its gaming business from new titles.
This week’s earnings releases:
0830 – ECB President Lagarde to speak
1430 – EIA's Weekly Crude and Fuel Stock Report
1730 – Canada Bank of Canada to release “summary of deliberations”
1800 – US FOMC announcement
1830 – US Fed Chair Powell Press Conference
2130 – Brazil Selic Rate Announcement
0015 – New Zealand RBNZ Chief Economist to speak on inflationDisclaimer
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